RBI Cuts Repo Rate By 25 bps To More Than 6-1/2 Year Low
The Reserve Bank of India (RBI) on Wednesday (2 August) has cut the repo rate by 25 basis points (bps) to six per cent – a seven-year low but lower from market expectation of a 50 bps cut in the same. All eyes will now be on banks – will they pass on the rate cut?
The decision of the Monetary Policy Committee (MPC) is consistent with a neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of plus or minus two per cent, while supporting growth.
It might be recalled Mint Road’s second bi-monthly statement had projected quarterly average headline inflation in the range of 2.0-3.5 per cent in the first half of the year and 3.5-4.5 per cent in the second half.
“The actual outcome for the first quarter has tracked projections. Looking ahead, as the base effects fade, the evolving momentum of inflation would be determined by (a) the impact on the CPI of the implementation of house rent allowances (HRA) under the 7th Central Pay Commission (CPC); (b) the impact of the price revisions withheld ahead of the GST; and (c) the disentangling of the structural and transitory factors shaping food inflation”, RBI governor Urjit Patel said.
While the rate cut today did not go as far as what India Inc wanted, Mint Road had come under pressure from both business chambers and the Centre. The Chief Economic Advisor Arvind Subramanian had on 8th June said: “Inflation forecast errors have been large and systematically one sided in overstating inflation. In this (alternative) view, the inflation outlook has been rendered benign by an appreciating exchange rate, a good monsoon and a capping of oil prices by structural shifts,” he had said.
Sub-head: Mint Road’s reading…
It was pointed several factors contribute to the uncertainty around the baseline inflation trajectory. The implementation of farm-loan waivers by States may result in possible fiscal slippages and undermine the quality of public spending, entailing inflationary spill-overs. Moreover, the timing of the States’ implementation of salary and allowances award is critical – it is not factored into the baseline projection in view of lack of information on their plans.
“If States choose to implement salary and allowance increases similar to the Centre in the current financial year, headline inflation could rise by an additional estimated 100 bps above the baseline over 18-24 months”, Mint Road said.
Other high-frequency indicators suggest price pressures are building up in vegetables and animal proteins in the near months. There are, however, some moderating forces at work. First, the second successive normal monsoon coupled with effective supply management measures may keep food inflation under check. Second, if the general moderation of price increases in CPI excluding food and fuel continues, it will contain upside pressures on headline inflation. Third, the international commodity price outlook is fairly stable at the current juncture.
Business sentiment polled in the manufacturing sector reflects expectations of moderation of activity in the second quarter of the fiscal from the preceding quarter. Moreover, high levels of stress in twin balance sheets – banks and corporations – are likely to deter new investment. With the real estate sector coming under the regulatory umbrella, new project launches may involve extended gestations and, along with the anticipated consolidation in the sector, may restrain growth, with spillovers to construction and ancillary activities. Also, given the limits on raising market borrowings and taxes by States, farm-loan waivers are likely to compel a cutback on capital expenditure, with adverse implications for the already damped capex cycle.
On the brighter side, the upside to the baseline projections emanate from the rising probability of another good kharif harvest, the boost to rural demand from the higher budgetary allocation to housing in rural areas, the significant step-up in the budgetary allocation for roads and bridges, and the growth-enhancing effects of the GST, viz., the shifting of trade from unorganised to organised segments; the reduction of tax cascades; cost, efficiency and competitiveness gains; and synergies in domestic supply chains.
The MPC observed while inflation has fallen to a historic low, a conclusive segregation of transitory and structural factors driving the disinflation is still elusive. In respect of inflation-sensitive vegetables, prices are recording spikes. Excess supply conditions continue to push down prices of pulses and keep those of cereals in check. The MPC will continue monitoring movements in inflation to ascertain if recent soft readings are transient or if a more durable disinflation is underway. In its assessment of real activity, the MPC noted that while the outlook for agriculture appears robust, underlying growth impulses in industry and services are weakening, given corporate deleveraging and the retrenchment of investment demand.
